Sample Business Contracts


Employment Agreement - NovaStar Financial Inc. and Scott F. Hartman

Employment Forms

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                             EMPLOYMENT AGREEMENT
                             --------------------

     THIS EMPLOYMENT AGREEMENT ("Agreement"), dated as of the 30th day of
September, 1996, is entered into by and between Scott F. Hartman ("Executive")
and NovaStar Financial, Inc., a Maryland corporation ("Company"), and is
effective as of and conditioned upon the completion of the Company's private
placement of up to 3,333,333 Units, each Unit consisting of one share of Class A
Convertible Preferred Stock and One Stock Purchase Warrant.

     The Company desires to establish its right to the continued services of the
Executive, in the capacity described below, on the terms and conditions and
subject to the rights of termination hereinafter set forth, and the Executive is
willing to accept such employment on such terms and conditions.

     In consideration of the mutual agreements hereinafter set forth, the
Executive and the Company have agreed and do hereby agree as follows:

     1.   EMPLOYMENT BY THE COMPANY.  The Company does hereby employ, engage and
          -------------------------                                             
hire the Executive as Chairman of the Board and Chief Executive Officer of the
Company, and the Executive does hereby accept and agree to such hiring,
engagement and employment.  The Executive's duties shall be such executive and
managerial duties as the Board of Directors of the Company or its subsidiaries
shall from time to time prescribe and as provided in the bylaws of the Company.
The terms of this Agreement shall be subject to the personnel policies of the
Company as determined by the Board of Directors from time to time, except to the
extent that any such policy would have a material adverse effect on the rights
of the Executive under the terms of this Agreement.  The Executive shall devote
such time, energy and skill to the performance of his duties for the Company and
for the benefit of the Company as may be necessary or required for the effective
conduct and operation of the Company's business.  Furthermore, the Executive
shall exercise due diligence and care in the performance of his duties to the
Company under this Agreement.

     2.   TERM OF AGREEMENT.  The term ("Term") of this Agreement shall commence
          -----------------                                                     
on the date of the closing of the private placement referred to above (the
"Effective Date") and shall continue through December 31, 2001; provided,
however, that on each December 31 commencing December 31, 1997 the Term of the
Agreement shall automatically be extended for one additional year unless, not
later than three months prior to any such December 31, either party shall have
given written notice to the other that it does not wish to extend the Term of
the Agreement.

     3.   COMPENSATION.

          (a) BASE SALARY.  The Company shall pay the Executive, and the
              -----------                                               
Executive agrees to accept from the Company, in payment for his services to the
Company beginning on the Effective Date, a base salary at the rate per annum to
be determined by the Compensation Committee of the Board of Directors and
provided to the Executive in writing ("Base Salary"), which is subject to change
upon thirty (30) days' notice and shall initially be set

                                       1
<PAGE>
 
at One Hundred Twenty Thousand Dollars ($120,000.00) until the closing of a firm
commitment underwritten initial public offering of the Common Stock resulting in
aggregate gross proceeds to the Company of at least $20 million and at a price
per share of at least $15.00 or such lesser amount of proceeds and/or lower
price per share as may be approved by two-thirds of the Preferred Stock (a
"Qualified IPO"), when said Base Salary shall be increased to One Hundred
Eighty-Five Thousand Dollars ($185,000.00). Base Salary is payable in equal
biweekly installments or at such other time or times as the Executive and
Company agree.

          (b) PERFORMANCE BONUS - BOARD OF DIRECTORS DISCRETION.  The Executive
              -------------------------------------------------                
shall be eligible to receive an incentive performance bonus in accordance with
the Bonus Incentive Compensation Plan established by the Company, which, during
the initial Term of this Agreement, shall substantially reflect the provisions
set forth in Exhibit A.  Except as provided in Section 7, any such bonus awarded
to the Executive shall be payable in the amount, in the manner and at the time
determined by the Compensation Committee of the Company's Board of Directors in
its sole and absolute discretion.

          (c) ANNUAL REVIEW.  The Compensation Committee of the Company's Board
              -------------                                                    
of Directors shall, at least annually, review the Executive's entire
compensation package to determine whether it continues to meet the Company's
compensation objectives.  Such annual review will include a determination of (i)
whether to increase the Base Salary set forth in Section 3(a) and (ii) the
incentive performance bonus to be awarded in accordance with Section 3(b).

          (d) UNITS ACQUIRED WITH FORGIVABLE DEBT.  Executive will acquire Units
              -----------------------------------                               
in the Company's private placement with a promissory note to the Company which
is forgivable during the initial term of this Agreement in accordance with the
terms of such note which shall substantially reflect the provisions set forth in
Exhibit B.

     4.   FRINGE BENEFITS.  The Executive shall be entitled to participate in
          ---------------                                                    
any benefit programs adopted from time to time by the Company for the benefit of
its executive employees at an appropriate level for the duties of the officer,
and the Executive shall be entitled to receive such other fringe benefits as may
be granted from time to time by the Company's Board of Directors or its
Compensation Committee.

          (a) BENEFIT PLANS.  The Executive shall be entitled to participate in
              -------------                                                    
any benefit plans relating to stock options, stock purchases, pension, thrift,
profit sharing, life insurance, medical coverage, education or other retirement
or employee benefits available to other executive employees of the Company at an
appropriate level for the duties of the office, subject to any restrictions
(including waiting periods) specified in such plans.  The Company shall make
commercially reasonable efforts to obtain medical and disability insurance, and
such other forms of insurance as the Board of Directors shall determine, for its
employees.

          (b) VACATION.  The Executive shall be entitled to four (4) weeks of
              --------                                                       
paid vacation per calendar year, with such vacation to be scheduled and taken in
accordance with the Company's standard vacation policies.

                                       2
<PAGE>
 
     5.   BUSINESS EXPENSES.  The Company shall reimburse the Executive for any
          -----------------                                                    
and all necessary, customary and usual expenses, properly receipted in
accordance with Company policies, incurred by the Executive on behalf of the
Company.

     6.   TERMINATION OF EXECUTIVE'S EMPLOYMENT.

          (a) DEATH.  If the Executive dies while employed by the Company, his
              -----                                                           
employment shall immediately terminate.  The Company's obligation to pay the
Executive's Base Salary shall cease as of the date of Executive's death.
Thereafter, Executive's beneficiaries or his estate shall receive benefits in
accordance with the Company's retirement, insurance and other applicable
programs and plans then in effect.

          (b)  DISABILITY.
               ---------- 

          (i)  If, as a result of the Executive's incapacity due to physical or
mental illness ("Disability"), Executive shall have been absent from the full-
time performance of his duties with the Company for six (6) consecutive months,
and, within thirty (30) days after written notice is provided to him by the
Company, he shall not have returned to the full-time performance of his duties,
the Executive's employment under this Agreement may be terminated by the Company
for Disability.  During any period prior to such termination during which the
Executive is absent from the full-time performance of his duties with the
Company due to Disability, the Company shall continue to pay the Executive his
Base Salary at the rate in effect at the commencement of such period of
Disability.  Subsequent to such termination, the Executive's benefits shall be
determined under the Company's retirement, insurance and other compensation
programs then in effect in accordance with the terms of such programs.

          (ii)  If, however, as a result of the Executive's partial incapacity
due to physical or mental illness in which Executive shall not have been absent
from his duties for six consecutive months and shall have returned to work on a
full-time basis but is not able to perform at the same level as when hired
and/or is not able to perform the same functions for which originally hired
("Partial Disability"), the Company shall make reasonable efforts to accommodate
the Executive's Partial Disability by modifying his job description
appropriately, together with a commensurate adjustment in compensation;
provided, however, the Company shall be required to so continue the employment
of the Executive in the event of a Partial Disability of the Executive only if
the Company determines, in its sole discretion, that it can create a position
for which the Executive would be suited and that would be economically
advantageous to the Company.

          (c) TERMINATION BY THE COMPANY FOR CAUSE.  The Company may terminate
              ------------------------------------                            
the Executive's employment under this Agreement for "Cause," at any time prior
to expiration of the Term of the Agreement, only in the event of (i) acts or
omissions constituting gross negligence, recklessness or willful misconduct on
the part of the Executive in respect of his fiduciary obligations or otherwise
relating to the business of the Company, (ii) the Executive's material breach of
this Agreement, or (iii) the Executive's conviction or entry of a plea of nolo
contendre for fraud, misappropriation or embezzlement.  In such a case, the
Executive's employment under this Agreement may be terminated immediately
without any advance written

                                       3
<PAGE>
 
notice, and the Company's obligation to pay the Executive's Base Salary, any
bonus and fringe benefits will cease as of the termination date.

          (d) TERMINATION BY THE EXECUTIVE FOR GOOD REASON.  The Executive shall
              --------------------------------------------                      
have the right to terminate this Agreement for Good Reason.  For purposes of
this Agreement, "Good Reason" shall mean the occurrence, without the Executive's
express written consent, of any one or more of the following events:

              (i) A reduction in title and/or compensation of the Executive or
the assignment of duties to the Executive not consistent with those of an
executive of the Company, except in connection with the Company's termination of
the Executive's employment for Cause pursuant to Section 6(c) or as otherwise
expressly contemplated herein;

              (ii) The Company's material breach of any of the provisions of
this Agreement, including, but not limited to, a reduction by the Company in the
Executive's Base Salary in effect as of the Effective Date; or a change in the
conditions of the Executive's employment (e.g., including, without limitation, a
                                          ----                                  
failure by the Company to provide the Executive with incentive compensation and
benefits plans that provide benefits and the opportunity to obtain incentive
compensation, in each case comparable to those available under benefits programs
in effect as of the Effective Date and at an appropriate level for the duties of
the officer, etc.); or

              (iii) The relocation of the Company's principal executive offices
to a location more than fifty (50) miles from its location as of the Effective
Date or the Company's requiring the Executive to be based anywhere other than
the Company's principal executive offices, except for requiring travel on the
Company's business to an extent substantially consistent with the Executive's
duties hereunder.

The Executive agrees to provide the Company with thirty (30) days' prior written
notice of any termination for Good Reason.

          (e) TERMINATION BY THE EXECUTIVE WITHOUT GOOD REASON.  The Executive
              ------------------------------------------------                
may at any time during the Term of this Agreement terminate his employment
hereunder for any reason or no reason by giving the Company notice in writing
not less than one hundred twenty (120) days in advance of such termination.
Except as may be provided in Section 9, the Executive shall have no further
obligations to the Company after the effective date of termination, as set forth
in the notice.  Notwithstanding the foregoing, in the event any "person" (as
defined in Section 8 below) begins a tender or exchange offer, circulates a
proxy to shareholders or takes other steps to effect a Change of Control, the
Executive agrees that he will not voluntarily leave the employ of the Company,
and will render services to the Company commensurate with his position, until
such "person" has abandoned or terminated efforts to effect a Change of Control
or until a Change of Control has occurred.  In the event of a termination by the
Executive under this paragraph, the Company will pay only the portion of Base
Salary or previously awarded bonus unpaid as of the termination date.  Fringe
benefits which have accrued and/or vested on the termination date will continue
in effect according to their terms, but no additional accrual or vesting will
take place.

                                       4
<PAGE>
 
     7.A. COMPENSATION UPON TERMINATION BY THE COMPANY AFTER CHANGE IN CONTROL
          --------------------------------------------------------------------
OTHER THAN FOR CAUSE, OR BY THE EXECUTIVE FOR GOOD REASON.  If the Executive's
---------------------------------------------------------                     
employment shall be terminated after a Change in Control as defined in Section 8
(i) by the Company other than for Cause, or (ii) by the Executive for Good
Reason, the Executive shall be entitled to the following benefits:

          (a) PAYMENT OF UNPAID BASE SALARY.  The Company shall immediately pay
              -----------------------------                                    
the Executive any portion of the Executive's Base Salary or previously awarded
Bonus not paid prior to the termination date.

          (b) SEVERANCE PAYMENT.  The Company shall pay the Executive an amount
              -----------------                                                
(the "Severance Amount") equal to three times the Executive's combined current
year Base Salary and actual bonus compensation for the preceding fiscal year;
provided, however, the severance amount shall not be less then Three Hundred
Sixty Thousand Dollars ($360,000.00) nor more (once the minimum is reached) than
one percent (1.0%) of the book value of the Company (i.e., the amount reported
                                                     ----                     
on the Company's balance sheet prepared in accordance with generally accepted
accounting principles as stockholders' equity).  The Severance Amount shall be
payable fifty percent (50%) within five (5) days after the termination date and
the remaining fifty percent (50%) shall be payable in twelve (12) equal
consecutive monthly installments beginning on the first day of the month
following the termination date.

          (c) IMMEDIATE VESTING OF STOCK OPTIONS.  The Company shall take all
              ----------------------------------                             
appropriate action to ensure that all stock options on the Company's stock owned
by the Executive as of the Effective Date and which have not been exercised
prior to the termination date become immediately exercisable by the Executive,
whether or not the right to exercise such stock options would otherwise then be
vested in the Executive.  The provisions of this Section 7(c) shall constitute
an amendment to any existing stock option agreements of the Company as of the
Effective Date.  All other stock options owned by the Executive as of the
termination date shall be exercisable in accordance with the Company's stock
option plan and the applicable stock option agreements.

          (d) CONTINUATION OF FRINGE BENEFITS.  From and after termination of
              -------------------------------                                
the Executive's employment, the Company shall continue to provide the Executive
with all life insurance and medical coverage fringe benefits set forth in
Section 4 as if the Executive's employment under the Agreement had not been
terminated until the earlier to occur of (i) such time as the Executive finds
full-time employment or (ii) the expiration of three years.  Notwithstanding the
immediately preceding sentence, if, as the result of termination of the
Executive's employment, the Executive and/or his otherwise eligible dependents
or beneficiaries shall become ineligible for benefits under any one of the
Company's benefit plans or the cost of providing such benefits exceeds two
hundred percent (200%) of the cost of providing such benefits to other members
of senior management, the Company, at the Company's option, shall (i) continue
to provide the Executive and his eligible dependents or beneficiaries with
benefits at a level at least equivalent to the level of benefits for which the
Executive and his dependents and beneficiaries were eligible under such plans
immediately prior to the termination date or (ii) for any fringe benefit not so
provided, the Company shall pay the Executive 200% of the cost of providing such
fringe benefit to other members of senior management.

                                       5
<PAGE>
 
     7.B. COMPENSATION UPON TERMINATION BY THE COMPANY OTHER THAN FOR CAUSE, OR
          ---------------------------------------------------------------------
BY THE EXECUTIVE FOR GOOD REASON.  If the Executive's employment shall be
--------------------------------                                         
terminated either (i) by the Company other than for Cause, or (ii) by the
Executive for Good Reason, the Executive shall be entitled to the following
benefits:

          (a) PAYMENT OF UNPAID BASE SALARY.  The Company shall immediately pay
              -----------------------------                                    
the Executive any portion of the Executive's Base Salary or previously awarded
Bonus not paid prior to the termination date.

          (b) SEVERANCE PAYMENT.  The Company shall pay the Executive an amount
              -----------------                                                
(the "Severance Amount") equal to the Executive's combined current year Base
Salary and actual bonus compensation for the preceding fiscal year; provided,
however, the severance amount shall not be less than One Hundred Twenty Thousand
Dollars ($120,000.00) nor more (once the minimum is reached) than one percent
(1.0%) of the book value of the Company (i.e., the amount reported on the
                                         ----                            
Company's balance sheet prepared in accordance with generally accepted
accounting principles as stockholders' equity).  The Severance Amount shall be
payable immediately upon the termination date.

          (c) STOCK OPTIONS.  Stock options owned by the Executive as of the
              -------------                                                 
termination date shall be exercisable in accordance with the Company's stock
option plan and the applicable stock option agreements.

          (d) CONTINUATION OF FRINGE BENEFITS.  From and after termination of
              -------------------------------                                
the Executive's employment, the Company shall continue to provide the Executive
with all life insurance and medical coverage fringe benefits set forth in
Section 4 as if the Executive's employment under the Agreement had not been
terminated until the earlier to occur of (i) such time as the Executive finds
full-time employment or (ii) the expiration of one (1) year. Notwithstanding the
immediately preceding sentence, if, as the result of termination of the
Executive's employment, the Executive and/or his otherwise eligible dependents
or beneficiaries shall become ineligible for benefits under any one of the
Company's benefit plans or the cost of providing such benefits exceeds two
hundred percent (200%) of the cost of providing such benefits to other members
of senior management, the Company, at the Company's option, shall (i) continue
to provide the Executive and his eligible dependents or beneficiaries with
benefits at a level at least equivalent to the level of benefits for which the
Executive and his dependents and beneficiaries were eligible under such plans
immediately prior to the termination date or (ii) for any fringe benefit not so
provided, the Company shall pay the Executive 200% of the cost of providing such
fringe benefit to other members of senior management.

     7.C. NO MITIGATION REQUIRED; NO OTHER ENTITLEMENT TO BENEFITS UNDER
          --------------------------------------------------------------
AGREEMENT.  The Executive shall not be required in any way to mitigate the
---------                                                                 
amount of any payment provided for in this Section 7, including, but not limited
to, by seeking other employment, nor shall the amount of any payment provided
for in this Section 7 be reduced by any compensation earned by the Executive as
a result of employment with another employer after the termination date of
employment, or otherwise.  Except as set forth in this Section 7, following a
termination governed by this Section 7, the Executive shall not be entitled to
any other compensation or benefits set forth in this Agreement, except as may be
separately

                                       6
<PAGE>
 
negotiated by the parties and approved by the Board of Directors of the Company
in writing in conjunction with the termination of Executive's employment under
this Section 7.

     8.   CHANGE IN CONTROL.  A "Change in Control" shall be deemed to have
          -----------------                                                
occurred if the conditions set forth in any one of the following paragraphs
shall have been satisfied.

          (a) Any "person," as such term is used in Sections 13(d) and 14(d) of
the Securities Exchange Act of 1934 (the "Exchange Act") (other than the
Company; any trustee or other fiduciary holding securities under an Executive
benefit plan of the Company; or any company owned, directly or indirectly, by
the stockholders of the Company in substantially the same proportions as their
ownership of the stock of the Company), is or becomes the "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of the
securities of the Company (not including in the securities beneficially owned by
such person, any securities acquired directly from the Company or from a
transferor in a transaction expressly approved or consented to by the Board of
Directors) representing more than 25% of the combined voting power of the
Company's then outstanding securities; or

          (b) During any period of two consecutive years (not including any
period prior to the execution of this Agreement), individuals who at the
beginning of such period constitute the Board of Directors and any new director
(other than a director designated by a person who has entered into an agreement
with the Company to effect a transaction described in clause (a), (c) or (d) of
this section), (i) whose election by the Board of Directors or nomination for
election by the Company's stockholders was approved by a vote of at least two-
thirds (2/3) of the directors then still in office who either were directors at
the beginning of the period or whose election or nomination for election was
previously so approved or (ii) whose election is to replace a person who ceases
to be a director due to death, disability or age, cease for any reason to
constitute a majority thereof; or

          (c) The shareholders of the Company approve a merger or consolidation
of the Company with other corporation, other than (i) a merger or consolidation
which would result in the voting securities of the Company outstanding
immediately prior thereto continuing to represent (either by remaining
outstanding or by being converted into voting securities of the surviving
entity), in combination with the ownership of any trustee or other fiduciary
holding securities under an Executive benefit plan of the Company, at least 75%
of the combined voting power of the voting securities of the Company or such
surviving entity outstanding immediately after such merger or consolidation, or
(ii) a merger or consolidation effected to implement a recapitalization of the
Company (or similar transaction) in which no person acquires more than 50% of
the combined voting power of the Company's then outstanding securities; or

          (d) The shareholders of the Company approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or substantially all the Company's assets.

                                       7
<PAGE>
 
     9.   NONCOMPETITION PROVISIONS.
          ------------------------- 

          (a) NONCOMPETITION.  The Executive agrees that during the Term of this
              --------------                                                    
Agreement prior to any termination of his employment hereunder and for a period
of twelve (12) months following either (i) the occurrence of any event entitling
the Executive to Benefit Payments according to the provisions of Section 7.A,
provided the Company makes all such payments when due, or (ii) a resignation by
the Executive other than for Good Reason, he will not directly or indirectly,
without the prior written consent of the Company, manage, operate, join,
control, participate in, or be connected as a stockholder (other than as a
holder of shares publicly traded on a stock exchange or the NASDAQ National
Market System), partner, or other equity holder with, or as an officer, director
or employee of, any other subprime real estate lender or any real estate
investment trust  whose business strategy is competitive with that of the
Company, as determined by a majority of the Company's independent directors
("Competing Business").  It is further expressly agreed that the Company will or
would suffer irreparable injury if the Executive were to compete with the
Company or any subsidiary or affiliate of the Company in violation of this
Agreement and that the Company would by reason of such competition be entitled
to injunctive relief in a court of appropriate jurisdiction, and the Executive
further consents and stipulates to the entry of such injunctive relief in such a
court prohibiting the Executive from competing with the Company or any
subsidiary or affiliate of the Company, in the areas of business set forth
above, in violation of this Agreement.

          (b) RIGHT TO COMPANY MATERIALS.  The Executive agrees that all styles,
              --------------------------                                        
designs, lists, materials, books, files, reports, correspondence, records and
other documents ("Company Materials") used, prepared or made available to the
Executive, shall be and shall remain the property of the Company.  Upon the
termination of employment or the expiration of this Agreement, all Company
Materials shall be returned immediately to the Company, and the Executive shall
not make or retain any copies thereof.

          (c) SOLICITING EXECUTIVES.  The Executive promises and agrees that
              ---------------------                                         
during the noncompetition period defined in paragraph (a) he will not directly
or indirectly solicit any of the Company executives or employees to work for any
Competing Business.

     10.  NOTICES.  All notices and other communications under this Agreement
          -------                                                            
shall be in writing and shall be given by fax or first class mail, certified or
registered with return receipt requested, and shall be deemed to have been duly
given three (3) days after mailing or twenty-four (24) hours after transmission
of a fax to the respective persons named below:

     If to Company:                 NovaStar Financial, Inc.
                                    Attn:  Board of Directors
                                    1900 West 47th Place, Suite 205
                                    Westwood, KS  66205
                                    Phone: (913) 362-1090
                                    Fax:    (913) 362-1011

                                       8
<PAGE>
 
     If to Executive:               Scott F. Hartman
                                    5315 W. 103rd Place
                                    Overland Park, KS  66207
                                    Phone:  (913) 522-1336

Either party may change such party's address for notices by notice duly given
pursuant hereto.

     11.  ATTORNEYS' FEES.  In the event judicial determination is necessary of
          ---------------                                                      
any dispute arising as to the parties' rights and obligations hereunder, each
party shall have the right, in addition to any other relief granted by the
court, to attorneys' fees based on a determination by the court of the extent to
which each party has prevailed as to the material issues raised in determination
of the dispute.

     12.  TERMINATION OF PRIOR AGREEMENTS.  This Agreement terminates and
          -------------------------------                                
supersedes any and all prior agreements and understandings between the parties
with respect to employment or with respect to the compensation of the Executive
by the Company.

     13.  ASSIGNMENT; SUCCESSORS.  This Agreement is personal in its nature and
          ----------------------                                               
neither of the parties hereto shall, without the consent of the other, assign or
transfer this Agreement or any rights or obligations hereunder; provided that,
in the event of the merger, consolidation, transfer, or sale of all or
substantially all of the assets of the Company with or to any other individual
or entity, this Agreement shall, subject to the provisions hereof, be binding
upon and inure to the benefit of such successor and such successor shall
discharge and perform all the promises, covenants, duties, and obligations of
the Company hereunder.

     14.  GOVERNING LAW.  This Agreement and the legal relations thus created
          -------------                                                      
between the parties hereto shall be governed by and construed under and in
accordance with the laws of the State of New York.

     15.  ENTIRE AGREEMENT; HEADINGS.  This Agreement embodies the entire
          --------------------------                                     
agreement of the parties respecting the matters within its scope and may be
modified only in writing.  Section headings in this Agreement are included
herein for convenience of reference only and shall not constitute a part of this
Agreement for any other purpose.

     16.  WAIVER; MODIFICATION.  Failure to insist upon strict compliance with
          --------------------                                                
any of the terms, covenants or conditions hereof shall not be deemed a waiver of
such term, covenant or condition, nor shall any waiver or relinquishment of, or
failure to insist upon strict compliance with, any right or power hereunder at
any one or more times be deemed a waiver or relinquishment of such right or
power at any other time or times.  This Agreement shall not be modified in any
respect except by a writing executed by each party hereto.

     17.  SEVERABILITY.  In the event that a court of competent jurisdiction
          ------------                                                      
determines that any portion of this Agreement is in violation of any statute or
public policy, only the portions of this Agreement that violate such statute or
public policy shall be stricken.  All portions of this Agreement that do not
violate any statute or public policy shall continue in full force and effect.
Further, any court order striking any portion of this Agreement shall modify the

                                       9
<PAGE>
 
stricken terms as narrowly as possible to give as much effect as possible to the
intentions of the parties under this Agreement.

     18.  INDEMNIFICATION.  The Company shall indemnify and hold Executive
          ---------------                                                 
harmless to the maximum extent permitted by Maryland Law and the Bylaws of the
Company.

     19.  COUNTERPARTS.  This Agreement may be executed in counterparts.
          ------------                                                  

     IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by
its duly authorized officer, and the Executive has hereunto signed this
Agreement, as of the date first above written.


                                   NOVASTAR FINANCIAL, INC.,
                                   a Maryland corporation


                                 By
                                   --------------------------------

 

                                   --------------------------------
                                   SCOTT F. HARTMAN

                                       10
<PAGE>
 
                                   EXHIBIT A

                       BONUS INCENTIVE COMPENSATION PLAN

     The Bonus Incentive Compensation Plan shall be effective commencing with
the first full fiscal year after the closing of a firm commitment underwritten
initial public offering of the Common Stock resulting in aggregate gross
proceeds to the Company of at least $20 million and at a price of at least $15
or such lessor amount of proceeds and/or lower price per share as may be
approved by two-thirds of the Preferred Stock (a "Qualified IPO").

     The annual bonus pursuant to the Bonus Incentive Compensation Plan will be
paid one-half in cash and one-half in shares of Common Stock of the Company,
annually, following receipt of the audit for the related fiscal year.  This
program will award bonuses annually to those officers out of a total pool
determined by shareholder return on equity ("ROE") as follows:
 
 

     ROE/(1)/ in Excess of Base Rate/(2)/ By:    Bonus as % of Average Net
     ----------------------------------------    -------------------------
                                                 Worth/(3)/ Outstanding
                                                 -------------------------
     
                                               
     zero or less                                0%

     greater than 0% but less than 6%            10% * (actual ROE - Base Rate)

     Greater than 6%                            (10% * 6%) + 15% * (Actual

                                                 ROE - (Base Rate + 6%))
 

     Of the amount so determined, one-half will be deemed contributed to the
total pool in cash and the other half deemed contributed to the total pool in
the form of shares of Common Stock, with the number of shares to be calculated
based on the average price per share during the preceding year.  The total pool
may not exceed $1 million for fiscal years ending December 31, 1998 and December
31, 1999.
_______________________

/(1) /"ROE" is determined for the fiscal year by averaging the monthly ratios
     calculated each month by dividing the Company's monthly Net Income
     (adjusted to an annual rate) by its Average Net Worth for such month.  For
     such calculations, the "Net Income" of the Company means the net income or
     net loss of the Company determined according to GAAP, but after deducting
     any dividends paid or payable on preferred stock issued after the Qualified
     IPO and before giving effect to the bonus incentive compensation or any
     valuation allowance adjustment to stockholders' equity.  The definition
     "ROE" is used only for purposes of calculating the bonus incentive
     compensation payable pursuant to the Bonus Incentive Compensation Plan, and
     is not related to the actual distributions received by stockholders.  The
     bonus payments will be made before any income distributions are made to
     stockholders.

/(2) /"Base Rate" is the average for each month of the Ten-Year U.S. Treasury
     Rate, plus 4%.

/(3) /"Average Net Worth" for any month means the arithmetic average of the sum
     of (i) the net proceeds from all offerings of equity securities by the
     Company since formation (but excluding any offerings of preferred stock
     subsequent to the Qualified IPO), after deducting any underwriting
     discounts and commissions and other expenses and costs relating to the
     offerings, plus (ii) the Company's retained earnings (without taking into
     account any losses incurred in prior fiscal years, after deducting any
     amounts reflecting taxable income to be distributed as dividends and
     without giving effect to any valuation allowance adjustment to
     stockholders' equity) computed by taking the daily average of such values
     during such period.
<PAGE>
 
                                   EXHIBIT B

                      UNITS ACQUIRED WITH FORGIVABLE DEBT

     In the Company's private placement, Messrs. Hartman and Anderson will each
acquire Units (in addition to the Units being offered to investors) at the price
of $15 per Unit, in the following amounts:


                          Aggregate No. of Units Sold at Offering
                         -----------------------------------------
 
                         Minimum (1,000,000)   Maximum (3,333,333)
                         -------------------   -------------------
 
                                         
          Mr. Hartman            50,000                108,333
          Mr. Anderson           50,000                108,333
 

     The number of Units to be acquired by each founder using forgivable debt
shall be equal to 50,000 Units plus 2.5% of the number of Units sold in excess
of the minimum number of Units in the Offering.

     Payment for such Units will be made by delivering to the Company promissory
notes, bearing interest at 8% per annum compounded annually and secured by the
Units being acquired. Interest will accrue during the first year and will be
added to principal due under the note.  Thereafter, interest will be payable
quarterly and upon forgiveness or at maturity of the notes, which is at the end
of the fifth fiscal period (as defined below).

     The principal amount of the notes will be divided into three equal
tranches.  Payment of principal on each tranche will be forgiven by the Company,
if the following incentive performance tests are achieved:

     .During the first five fiscal periods after issuance of the notes:


      -  One tranche will be forgiven for each fiscal period as to which the
         Company generates a total return to investors purchasing Units in the
         Company's private placement equal to or greater than 15%.

      -  At the end of each of the five fiscal periods, all remaining tranches
         will be forgiven if the Company has generated a total cumulative return
         to investors purchasing Units in the Company's private placement (from
         date of initial issuance of the notes) equal to or greater than 100%.

     .For purposes of calculating the returns to such investors:

      -  The term "fiscal period" will refer to each of five periods, the first
         commencing with the last closing of the Company's private placement and
         ending on December
<PAGE>
 
         31, 1997, and each succeeding fiscal period extending for twelve months
         and ending on each December 31.

     .The term "return" for each fiscal period will mean the sum of (on a per
      Unit basis) (a) all cash dividends paid during (or declared with respect
      to) such fiscal period per share of Preferred Stock (or per share of
      Common Stock following conversion of the Preferred Stock upon completion
      of a Qualified IPO), (b) any increase or decrease in the price per share
      of Preferred Stock (or resulting Common Stock) during such fiscal period,
      measured by using the price per Unit to investors in the Company's private
      placement as the starting price ($15.00), and using the average public
      trading price during the last 90 days of each succeeding fiscal period for
      such succeeding periods, and (c) any increase or decrease in the price per
      Warrant during such fiscal period, determined in the same manner as in
      (b). For purposes of the fiscal period 15% return test, the total return
      for a given period will be equal to the sum of (a), (b) and (c) during the
      period, and for purposes of the cumulative 100% return test, the amounts
      in (a), (b) and (c) will all be measured from the beginning of the first
      fiscal period. The amount of that "return" will then be measured as a
      percentage of the investors' investment in the Units (on a per Unit basis)
      without regard to timing of receipt of dividends or timing of increases in
      per share or per Warrant prices.

     .If one of the incentive tests is met, the amount of loan forgiveness for
      each tranche will be the principal amount of such tranche of the note. In
      addition, a loan will be made by the Company to Messrs. Hartman and
      Anderson in the amount of (i) personal tax liability resulting from the
      forgiveness of debt, and (ii) interest accrued during the first year on
      the forgiven tranches. The note will bear interest at a floating market
      rate, will be secured by that proportionate number of Units that had
      secured the forgiven tranche of the note and will mature upon the earlier
      of the sale of those Units (or the underlying securities) or the
      termination of the officer's employment with the Company.

     .At the election of the maker of each promissory note, the Company shall
      pay the premium on a term life insurance policy, the proceeds of which
      might assist such maker's estate or legal representative to cover the sums
      due under the promissory note, and the premium amount so advanced shall be
      added to the principal amount due the Company pursuant to the promissory
      note.


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